Because of the new trend and customer needs in beer industry, Boston Beer Company was able to grow rapidly. Exhibit 1 shows the tremendous growth of U.S. craft brewing industry barrels and Boston Beer Company is a beneficiary and one of the leading companies that take the lead of the craft brewing market growth. Furthermore, Boston Beer Companys outsourcing facilities in its early stage of the production and marketing approach to its customers lead the company to have the strategic advantage over its rival entities within competitive beer industry. Boston Beer Companys income statement and balance sheet (Exhibit 3, 4) show the company has been growing rapidly with a significant growth of revenue and income. Notable competitors public stock offering transaction also strengthen the idea that set range of the stock price (10 to 15 dollars) of the companys bankers can be adjusted to the level of its competitors (17 to 16 dollars per share) because of the growth rate of the company and its healthy financial situation.
Currently, Boston Beer using dual-class structure, Class A and Class B, for its equities part. The companys Class A Common Stock is not entitled to any voting rights, except for the right as a class to approve certain mergers and charter and by-law amendments and to elect a minority of the directors of the company. The Class B Common Stock has full voting rights. As of today, C. James Koch was the sole holder of record of all the companys issued and outstanding Class B Common Stock. Boston Beer chosen a dual-class structure for its IPO because it would like to ensure that the firms founders and top executives maintained control. Thus, dual-class shares satisfy owners who dont want to give up control, but do want the public equity market to provide financing. In some cases, company performance may benefit from the existence of dual-class shares. Founders often have a longer term vision than investors focused on the most recent quarterly figures.
Since stock that provides extra voting rights often cannot be traded, it ensures the company will have a set of loyal investors during rough patches. On the other hand, it can be seen as downright unfair. It creates an inferior class of shareholders and hand over power to a select few, who are then allowed to pass the financial risk onto others. Normally, the existence of dual class shares would be a problem if an investor believed the disproportionate voting rights were allowing inferior management to remain in place in spite of the best interests of shareholders. For outside investors, they should always research the details of a companys share classes if they are considering investing in a firm with more than one class. Due to the sole holder of companys Class B common stock, it means that The Class B shareholder has significant influence over the company.
Mr. Koch is able to exercise substantial influence over all matters requiring stockholder approval, including the composition of the board of directors and approval of equity-based and other executive compensation and other significant corporate matters. This could have the effect of delaying or preventing a change in control of the Company and will make most transactions difficult or impossible to accomplish without the support of Mr. Koch. The risk of investing in the Boston Beer Company first is located on the competitive pressures of the beer industry. With this situation, the profit margins will be declining due to competition on prices and higher production costs on specialty beers. Since the flavor is important for customers choices and the eruption of competition in the craft beer industry had increased the pressure to introduce new beers to maintain and grow market share, the research and development facility investment for new product development is increasing each year, together with the increased advertising, promotional and selling expenses.
With the expansion of scale and size of the company, Boston Beer also invested more and more on capital expenditures, in 1995 Boston Beer invested $4.5 million on capital expenditures increase and in 1996 invested another $13 million for related technology equipment at its contract brewing facilities. The large investment on asset-based financing arrangements could take large amount of cash flow and newer technology will raise the dilemma of more investment on updating for new equipment, which can cause the broken of normal cash flow operation. From Exhibit 5 we can see that the capital raised form initial Public Stock Offerings from 1993 to 1995 can vary a lot from $34 million in 1993 drop to about $19.8 million in 1994, the wave of raised capital can have large effect on decision making process.
There was always the potential that the IPO could be under-subscribed and therefore pulled from the market. Then the company would thus miss an opportunity to raise much-needed capital. Before the IPO, Boston Beer was organized as a limited partnership which would be dissolved in November 1995. And at the time of dissolution, the company would distribute $12.5 million to its existing partners, The IPO proceeds would be used to immediately repay the debt incurred in dissolving the original partnership. Also, the company was planning to use $7 million of the proceeds to fund capital expenditures in 1996, while the remaining proceeds were to be used to fund working capital expenses or invested in investment grade securities. Talking about the over-capitalization, this is a situation when total of owned and borrowed capital exceed its fixed and current assets. An over capitalized company can be like a very fat person who cannot carry his weight properly, which is, in great troubles. There are many causes of over capitalization.
First is the idle fund, money may be living idle in banks or in the form of low yield investments. Second is the over-valuation, some fixed assets, especially goodwill, may be over-valued. Third, the fall in value can let some inventories have much higher book value than the real economic value, according to the wave of price of inventories. And the forth, the inadequate depreciation provision can also be the reason for over-capitalization. For the fair value of stocks based on two different valuation methods; the discount cash flow model and the free cash flow model. First we use the discount cash flow method to value the Boston Beer Companys fair value. (Please see the analyze process in Exhibit 1) First, we use the income before tax from the exhibit 3 in the year 1995. Because the case did not offer the depreciation fee, we assume the depreciation to be 0. Even though the tax rate changes slightly every year, we use the tax rate in the year 1995.
From the form above, we can see the change in net working capital and capital expenditure is very small in the year 1995. But from the case we know that after the company raises money from the IPO, the company was planning to use $7 million of the proceeds to fund capital expenditures in 1996. And the remaining proceeds were to be used to fund working capital expenses or invested in investment grade securities. Because we are valuing the firm before IPO and do not know the exact number the firm will spend on the working capital and capital expenditure. We assume the firm will increase stable. We calculate the free cash flow of year 1995 using income before tax*(1-tax rate)-change in net working capital-capital expenditure. Then we use the growth rate from 1996 to 2000 to calculate each years estimate free cash flow. We use the discount rate 10%, the perpetuity growth rate 5% and the free cash flow of year 2000 to calculate the terminal value.
Terminal value= free cash flow in 2000*(1+growth rate) / (discount rate- growth rate). Then use the discount rate, all the free cash flow and the terminal value to calculate the fair value of the company. The value of the Boston Beer Company is around 244 million. From the exhibit 3 in the case, we know the shares outstanding in year 1995 are 18273000. The case said that a total of 3984215 shares were to be offered in Boston Beers IPO, of which the company would issue 2540379 shares to raise capital for expansion. In addition, existing partners would sell 1443836 shares. Therefore, the new issued share would be 2540379. After add the new issued share to the original shares, we can calculate the stock price using the fair value. So the stock price=fair value/ total shares outstanding.
The stock price we estimate is around 11.74 dollar/share. The second method is for the free cash flow model in evaluating the companys value.The first assumption is to assume that Boston Beer will pay dividend so that we can use the dividend discount model to find a fair value. The growth rates are 40% in 1996-1997 and 30% in 1998-1999 and 5 thereafter. We assumed that ROE will be constant at 47.39% and EPS in 1995 is 0.35 (both figures was given in the cases exhibit 3 but should use the annualized number). Retention ratio comes from growth/ROE. All assumptions are listed in the table below.
Based on these assumptions, we find that the fair value of stock at the time in the case should be $15.42. (Please see the exhibit 2) According to the statistic and analyze, we come to summarize the opinion on the short-term and long-term current outlook for Americas brewing industry, especially with respect to its international competitors. Brewers Association announced the fact that 2,075 US craft breweries operated and 2,126 total breweries operated as of July, 2012, the highest total since the 1880s.Overall U.S. beer sales were down an estimated 1.3% by volume in 2011, 1.2% in 2010. Imported beer sales were up 1% in 2011 and up 5% in 2010. However, craft brewers sold an estimated 11,468,152 barrels of beer in 2011, up from 10,133,571 in 2010.
These statistics suggest that imports and craft beers are in growth, while sales of main players in US beer market, such as AB InBev and MillerCoors, are declining. I assume this situation is going to last for a few years. Imports will keep increasing because a significant number of people, especially young drinks having been enjoy drinking quality beers. Craft beers are popular because the hallmark of craft beer and craft brewers is innovation and craft brewers have distinctive, individualistic approaches to connecting with their customers.
In the long term, US beer companies may increase their sales by brewing imported beers in US. AB InBev began brewing Becks-previously imported- at St Louis brewery earlier last year. Also, though almost all craft brewers are operation at or near their full capacity, many craft brewers cannot meet growing demand. Some brewers have increased their sales by outsourcing some of production. With more craft brewers increasing investment and production, we can predict that sales of craft beers will go up more in the future. (See Exhibit 3and 4)